| Investors use analyst forecasts in investing decisions and researchers use them in earnings-response-coefficient studies. Both forecast users are interested in understanding differences in forecast errors across firms and the incorporation of forecasts into stock prices. Related to these issues, researchers investigate differences in forecast errors and stock-price reactions to forecast errors for high-growth (growth) firms versus low-growth (value) firms. These studies use P/B and P/E ratios, sometimes interchangeably, as measures of expected growth. However, as Fairfield (1994), Penman (1996), and Danielson and Dowdell (2001) show, the two metrics are not interchangeable measures of expected growth, but instead provide complementary information on the different economic circumstances companies face.; This study compares forecast errors and stock-price reactions to forecast errors across firms facing different economic circumstances. Rather than categorizing firms into two groups---growth firms and value firms---based either on P/B or P/E separately, I categorize firms into five groups using PB and P/E Jointly: Growth firms, mature firms, turnaround firms, declining firms, and competitive firms. My results suggest that using PB and P/E together can help investors in their use of analyst forecasts in decision making and clarify previous research results on forecast errors and stock-price reactions to forecast errors that use the ratios separately.; I document forecast-error and stock-return/forecast-error relation differences between turnaround and mature firms and growth firms and declining firms, suggesting the importance of using P/B and P/E together to identify these different groups. The forecast-error differences between the groups continue to exist even after controlling for factors previously found to be related to forecast bias and accuracy. I observe that the relation between P/E and forecast errors depends on the P/B level, explaining the low overall relation between P/E and forecast errors that previous researchers find. Finally, I find that growth firms experience the most negative stock-price reaction to negative forecast errors, consistent with the low bias and high accuracy of forecasts for this group of firms. |
